Name That Trade $AAPL: Adding Yield To Your Precious

by Dan June 5, 2015 1:58 pm • Commentary

The general rule of thumb when selling volatility is to do so when options prices are high relative to the broad market, the underlying’s movement, and most importantly to its historical options prices. Sometimes though, vol is low for a reason. In the case of (AAPL), 30 day at the money implied vol is about 20% (blue below), is actually below the 30 day at the money realized vol (how much the stock is moving) at 22% (white below), and just off of the 2015 lows:

AAPL 1yr chart of 30 day at the money implied vol vs 30 day realized vol from Bloomberg
AAPL 1yr chart of 30 day at the money implied vol vs 30 day realized vol from Bloomberg

As for the stock’s movement, well the 3 month chart below shows the stock spending most of that period between $125 and $130:

AAPL 3 month chart from Bloomberg
AAPL 3 month chart from Bloomberg

Oh and why the sideways action?? AAPL actively buys the crap out of their stock.  As of April the company stated that they have bought back $80 billion worth of stock since they commenced buybacks 3 years ago, and its board has approved an additional $200 billion for buybacks and dividends between now and the end of 2017.  This activity is vol dampening, and the company’s history of accelerating buybacks puts a slight floor on the stock.

So you get it, options prices are low.  Aside from a meaningful product miss-fire or downgrade to guidance there are few reasons, aside from broad market weakness why the stock will go down in the near future.

At one point in the last month or so expectations were getting kind of high heading into Apple’s World Wide Developers Forum starting Monday, but as of late with Watch seemingly having had a muted release, Pay excitement abating, TV set top box not ready for prime-time and streaming music having an uphill battle with Spotify, investors are pricing in little movement next week. With the stock at $129, the June 12th (next Friday) 129 straddle is offered at $2.80, if you bought that now you would need about a 2.2% move in either direction to break-even.  Seems pretty cheap. I wouldn’t sell that given the backdrop of an increasingly jittery equity market, and the potential for a surprise, but buying it looks almost equally un-compelling.

But for those of you who are long and strong and you would have to pry the stock out of your cold dead hands, and are waiting for a pullback to buy more, then consider selling options vs your long stock to add potential yield to your holding, a buffer to the downside, and possibly a limit order to buy more stock at a discount:

Against 100 shares of AAPL at $129, Sell 1 of the July 125/135 strangle at 3.50

– Sell 1 July 125 put at 2.00

– Sell 1 July 135 call at 1.50

Break-even on July expiration:

– Adds yield/protection to a long stock position of up to 3.50 between 121.50 and 138.50 with full collection of 3.50 between 125 and 135.

-Upside: Stocked called away above 135 at an effective sale price of 138.50 (up about 7%) and

-Downside: put 100 shares of stock at 125 or below, at an effective price of 121.50 (down about 6%). Losses of the stock and the short puts below 121.50.

Rationale:  We chose July expiration as it will not catch earnings which will be the next identifiable catalyst.